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September 11, 2013

Institutions Using More Hedge Funds Since Lehman Crash

Rarely thought of as risk reducers by the general public, hedge funds are a big draw for institutions seeking to, well, hedge

The fifth anniversary of Lehman is now upon us, as are memories of financial weapons of mass destruction, TARP, quantitative easing and other still-lingering reminders of that event. Therefore, the vast majority of the investing public probably doesn’t view hedge funds at tools to reduce risk, yet that is an intended purpose.

It’s something institutions realize, and are increasingly looking to hedge funds for risk management and diversification, according to new research from Boston-based research firm Cerulli Associates.

"Our research shows that institutional investors overall have been steadily increasing the portion of their assets allocated to hedge funds over the past five years,” Michele Giuditta, associate director at Cerulli, said in a statement. “Endowment funds, family offices and foundations were early adopters and currently remain established investors."

Noting that institutional investors have been under “significant pressure” since 2008 to increase their portfolio returns without inflating their risk profiles, Giuditta notes, “[It’s] a tall order, and it has led many institutional managers toward a renewed interest in developing hedge fund products."

Pension investors, in particular, are responsible for the largest portion (55%) of institutional investor assets invested in hedge funds, he adds. Nonetheless, institutional investors overall have been steadily increasing the portion of their assets allocated to hedge funds during the past five years.

For instance, endowment funds, family offices, and foundations were early adopters and currently remain established investors. Endowments’ allocations to hedge funds have held stable at close to 19% during the past five years. For endowment funds, their relative flexibility with respect to illiquidity and lockup periods can sometimes be an advantage in terms of hedge fund investing, the firm claims.

Family offices and foundations have allocated at least 15% of their portfolio assets in hedge funds since 2009, and their allocations were inching closer to the 20% mark in the first quarter of this year, Cerulli finds.

Pension plans and sovereign wealth funds, meanwhile, have slowly increased the percentage of their assets invested in hedge funds as well. Lastly, Insurance companies appear to be the outlier from this group and have reduced their exposure to 2.4% in the first quarter from a five-year high of 3.8% in 2011.

Cerulli concludes that many institutional managers gained their first exposure to hedge funds via investments in fund-of-fund vehicles.

“Since 2009, however, funds of funds have faced intense scrutiny due to poor performance, exposure to fraudulent managers (such as Bernard Madoff and Amaranth Advisors), and high fees. These factors have combined to spur many institutional investors to prefer investing directly in single-manager hedge funds.”